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actions
of entrepreneurs, but merely directs a
de facto
windfall of wealth into the laps of the lucky
ones (
mutatis mutandis
when the supposed change is in the other direction). This fact has, I think,
been overlooked in some contemporary discussions of a practical policy aimed at stabilising prices.
It is true that in a society liable to change such a policy cannot be perfectly successful. But it does
not follow that every small temporary departure from price stability necessarily sets up a cumulative
disequilibrium.
III
We have shown that when effective demand is deficient there is under-employment of labour in the
sense that there are men unemployed who would be willing to work at less than the existing real
wage. Consequently, as effective demand increases, employment increases, though at a real wage
equal to or less than the existing one, until a point comes at which there is no surplus of labour
available at the then existing real wage; i.e. no more men (or hours of labour) available unless
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money-wages rise (from this point onwards)
faster
than prices. The next problem is to consider
what will happen If, when this point has been reached, expenditure still continues to increase.
Up to this point the decreasing return from applying more labour to a given capital equipment has
been offset by the acquiescence of labour in a diminishing real wage. But after this point a unit of
labour would require the inducement of the equivalent of an increased quantity of product, whereas
the yield from applying a further unit would be a diminished quantity of product. The conditions of
strict equilibrium require, therefore, that wages and prices, and consequently profits also, should all
rise in the same proportion as expenditure, the 'real' position, including the volume of output and
employment, being left unchanged in all respects. We have reached, that is to say, a situation in
which the crude quantity theory of money (interpreting 'velocity' to mean 'income-velocity') is fully
satisfied; for output does not alter and prices rise in exact proportion to
MV
.
Nevertheless there are certain practical qualifications to this conclusion which must be borne in
mind in applying it to an actual case:
(1) For a time at least, rising prices may delude entrepreneurs into increasing employment beyond
the level which maximises their individual profits measured in terms of the product. For they are so
accustomed to regard rising sale-proceeds in terms of money as a signal for expanding production,
that they may continue to do so when this policy has in fact ceased to be to their best advantage; i.e.
they may underestimate their marginal user cost in the new price environment.
(2) Since that part of his profit which the entrepreneur has to hand on to the rentier is fixed in terms
of money, rising prices, even though unaccompanied by any change in output, will redistribute
incomes to the advantage of the entrepreneur and to the disadvantage of the rentier, which may have
a reaction on the propensity to consume. This, however, is not a process which will have only begun
when full employment has been attained;—it will have been making steady progress all the time
that the expenditure was increasing. If the rentier is less prone to spend than the entrepreneur, the
gradual withdrawal of real income from the ormer will mean that full employment will be reached
with a smaller increase in the quantity of money and a smaller reduction in the rate of interest than
will be the case if the opposite hypothesis holds. After full employment has been reached, a further
rise of prices will, if the first hypothesis continues to hold, mean that the rate of interest will have to
rise somewhat to prevent prices from rising indefinitely, and that the increase in the quantity of
money will be less than in proportion to the increase in expenditure; whilst if the second hypothesis
holds, the opposite will be the case. It may be that, as the real income of the rentier is diminished, a
point will come when, as a result of his growing relative impoverishment, there will be a change-
over from the first hypothesis to the second, which point may be reached either before or after full
employment has been attained.
IV
There is, perhaps, something a little perplexing in the apparent asymmetry between inflation and
deflation. For whilst a deflation of effective demand below the level required for full employment
will diminish employment as well as prices, an inflation of it above this level will merely affect
prices. This asymmetry is, however, merely a reflection of the fact that, whilst labour is always in a
position to refuse to work on a scale involving a real wage which is less than the marginal disutility
of that amount of employment, it is not in a position to insist on being offered work on a scale
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involving a real wage which is not greater than the marginal disutility of that amount of
employment.
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